There are several other good plans that address the underlying problems of the financial crisis, rather than throw money at the symptoms as Paulson and Bernanke are doing. The Genesis Plan, Plan B by Luigi Zingales of Chicago GSB, and Janet Tavakoli of Tavakoli Structured Finance are a few of them.
We concerned citizens really need to consolidate these into a united front, and use them as a framework for re-educating Congress on how to correctly address this financial crisis. So far it has been more a case study in the blind leading the blind.
The plans:
To aggregate and summarize all three:
1. Congress forces 100% balance sheet transparency on all publicly traded companies. No more Level 3, no more SIVs, no more hidden 'assets'. If there is no market for a particular 'asset', its value is marked $0.
The credit markets are frozen not due to illiquidity, but to lack of trust among banks (they all suspect each other of being technically insolvent, and no one wants to lend to another potential Bear or Lehman). That should have been obvious when LIBOR spiked after Lehman failed, but apparently not. Returning full transparency to the system is the first step in returning trust, allowing the sytem to function normally again.
[Slight digression - though there is a reasonable debate over intrinsic vs. market value, the problem is that many securities and instruments have become so complex and opaque that no one, not even their creators apparently, fully understand the risks, and thus value, of these things. The only way to value them right now is mark-to-market - if intrinsic value can be reliably determined, the market will value them as such.]
2. #1 will expose many companies as distressed or insolvent, some of which are necessary for a working financial system and some of which are not. The solution to this is forced restructuring that puts first losses on stock and bondholders, as is supposed to happen in capitalism, not a taxpayer bailout that shifts the risks and losses to the Federal balance sheet and currency. A capital structure 'cramdown' that wipes out current equity and converts outstanding bonds to new equity is usual way of accomplishing this. Stockholders lose 100%, and bondholders take a partial loss but are left with equity in a still-functioning, productive company with a clean, debt-free balance sheet, able to return to making money unimpaired. If further capital infusion is still needed after the restructuring, the Fed and Treasury can triage at much less cost and risk. This step is covered in detail by all three plans, and by dr. Enriquez's plan as well.
3. Require all derivatives to be traded on a margin-requirement-enforcing exchange. No more OTC contracts that can stealthily balloon into a $66T tangle of 'weapons of financial mass destruction'.
4. Reinstate the historically safe 12:1 leverage cap requirement (that incidentally Hank Paulson, lobbying in 2004, got repealed).
5. Restructure and workout bad mortgages so as to allow an orderly housing price regression to the historical mean of no more than 3.5x to 4x salary levels, while mitigating as much as possible the damage to currently outstanding securitized mortgage instruments. Zingales covers this in detail.
6. If Congress insists on throwing money at the problem, then there is a better way than injecting it into financial institutions that made bad decisions. Instead, use the $700B bailout to seed 7 new national banks, each with $100B in assets. Get them running, then IPO them off to the private sector at a price that guarantees the US Govt. gets its money back. Allow other banks to fail, and these to take their place. With, say, a 10% required reserve ratio, that $700B investment can expand into a $7T cash/credit injection into the economy at large. With no bad debt on their books, these new banks have no incentive to horde, and all the incentive to lend to quality borrowers. The system is preserved, moral hazard is avoided, and the rest of the American economy does not suffer due to the bad decisions of a few in the financial industry.
I hope Dr. Enriquez is open to incorporating the ideas from these plans where they make sense. It seems Congress only listens these days to people with a Harvard degree or Goldman Sachs pedigree, and the latter is turning out to be more of a conflict of interest and hinderance to getting this problem solved. Maybe a famous Harvard professor can get through to them.
Thank you again to Dr. Enriquez for your work on this problem!
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